Inflation on 'Sale' as Deflation Dominates Markets 26 comments
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By Eric Roseman
The time to start building fresh positions in oil, gold, silver and TIPs has arrived. Even distressed real estate should be accumulated if credit can be secured.
Over the next 6-12 months the United States, Europeans, Japanese and Chinese will eventually arrest deflation. And long before that materializes, hard assets will begin a major reversal following months of crippling losses.
Since peaking in July, the entire gamut of inflation assets has collapsed amid a growing threat of deflation or an environment of accelerated price declines. The last deflation in the United States occurred in the 1930s, purging household balance sheets, corporations, states, municipalities and even the government following two New Deals.
Thus far, U.S. CPI or the consumer price index has not turned negative year-over-year. Yet as oil prices continue to lose altitude and other commodities have been crushed, input costs and price pressures continue to decline dramatically since October. The only major component of CPI that continues to post modest year-over-year gains is wages. And with unemployment now rising aggressively this quarter it's highly likely wage demands will also come to a screeching halt.
Plunging Bond Yields Discount Danger
In the span of just six months, foreign currencies (except the yen), commodities, stocks, non-Treasury debt, real estate and art have all declined sharply in value in the worst panic-related sell-off in decades. More than $10 trillion dollars' worth of asset value has been lost worldwide in 2008.
What's working since July? U.S. Treasury bonds and the U.S. dollar as investors scramble for safety and liquidity.
On December 5, 30-day and 60-day T-bills yielded just 0.01% - the lowest since the 1930s while the benchmark 10-year T-bond traded below 2.55% - its lowest yield since Eisenhower was president in 1955. Even 30-year bonds have surged as the yield recently dropped below 3% for the first time in more than four decades.
The market is now pricing a severe recession and - possibly - another Great Depression. Despite a series of formidable regular market interventions by central banks since August 2007, the credit crisis is still alive and kicking. The authorities have not won the battle ...at least not yet.
Heightened inter-bank lending rates, soaring credit default swaps for sovereign government debt and plunging Treasury yields all confirm that the primary trend is still deflation.
To be sure, credit markets worldwide have improved markedly since the dark days of early October. Investment-grade corporate debt is rallying, commercial-paper is flowing again and companies are starting to issue debt once more - but only the highest and most liquid of companies. For the most part, banks are still hoarding cash and borrowers can't obtain credit.
The real economy is now feeling the bite as consumption falls off a cliff, foreclosures soar and the unemployment rate surges higher. These primary trends are deflationary as broad consumption is severely curtailed, with consumers preparing for the worst economy since 1981 and rebuilding devastated household balance sheets.
But at some point over the next 12 months, the market might transition from outright deflation or negative consumer prices to some sort of disinflation or at least an environment of stable prices. That's when inflation assets should start rallying again.
Inflate or Die: The Name of the Game in 2009
The battle now being waged by global central banks, including the Federal Reserve is an outright attack on deflation. Through the massive expansion of credit, the Fed and her overseas colleagues are on course to print money like there's no tomorrow to finance bulging fiscal spending plans, bailouts, tax cuts and anything else that helps to alleviate economic stress.
Earlier in November, the Fed announced it would target "quantitative easing" and "monetization," unorthodox monetary policy tools rarely or never used in the post-WW II era.
Without getting too technical, the term "quantitative easing" means the Fed will act as the buyer of last resort to monetize Treasury debt and other government agency paper in an attempt to bring interest rates down. Quantitative easing aims to flood the financial system with liquidity and absorb excess cash through monetization or purchasing of government securities.
Through monetary policy, the Fed controls short-term lending rates but cannot influence long-term rates that are largely set by the markets; the Fed now hopes it can influence long-term rates through quantitative easing. And since its announcement two weeks ago, long-term fixed mortgage rates have declined sharply.
These and other open market operations directed by the Fed and Treasury will eventually arrest the broad-based deflation engulfing asset prices. It will take time. Inflation is the desired goal and is the preferred evil to deflation, a monetary phenomenon that threatens to destroy or seriously compromise the financial system. Policy-makers have studied the Great Depression, including Fed Chairman Bernanke, and the consequences of failed central bank and government intervention in times of severe economic duress are unthinkable.
Ravenous Monetary Expansion
According to Federal Reserve Board data, the Fed is now embarking on a spectacular expansion of credit unseen in the history of modern financial markets.
The total amount of Federal Reserve bank credit has increased from $800 billion dollars to $2.2 trillion dollars (or from 6% to 15% of gross domestic product) as the central bank expands its various liquidity facilities in an attempt to preserve normal functioning of the financial system.
The Fed's ongoing operations to arrest falling prices are targeted namely at housing - the epicenter of this financial crisis. It is highly unlikely that the United States economy will bottom until housing prices find a floor. Quantitative easing hopes to stabilize this market.
Buy Gold Now
Relative to other assets in 2008, gold prices have declined far less. The ongoing liquidity squeeze has forced investors to dump assets, including gold to raise dollars. I suspect this short-term phenomenon will end in 2009 once the ongoing panic subsides and credit markets become largely functional again.
Gold should be accumulated now ahead of market stabilization. As the financial system gradually comes back to life over the next several months or sooner, the dollar should commence another period of weakness; there will be little incentive to hold dollars with short-term rates at or close to zero percent. The Fed will be in no hurry to raise lending rates.
Still, the Japanese experience in the 1990s warns investors of the travails of long-term deflation.
The Japanese, unlike the United States, only started to seriously attack falling prices in the economy in 1998 through massive fiscal spending. In contrast, the U.S. is already throwing everything at the crisis after just 17 months.
I expect the United States to print its way out of misery and, over time, and conquer deflation. But the cost will be humungous and at the expense of the dollar, U.S. financial hegemony and calls for a new monetary system anchored by gold.
It's literally "inflate or die" for global central banks. Inflation will win.
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This article has 26 comments:
After the incredible shopping binge of the past decade, many younger consumers are satiated, now realizing that they don't need 10 handbags or 8 pairs of shoes, etc.
Demand can be also be stiffled simply by demographics. Retiring baby boomers are downsizing their houses to simplify their lives, so regardless of financial means, they don't have the demand for cars, appliances, furniture, remodelling, etc, that they had a few years ago.
Thus, I think that easing money does not necessarily rekindle hyperdemand, and I suspect this is akin to what happened in Japan.
On Dec 10 09:21 AM Carl Spackler wrote:
> Gold prices have already priced in a reasonable surge of inflation
> since they have fallen much less than other commodities - see gold
> to siver ratio. If there is not appreciable pickup soon, you could
> see gold fall to $600. I agree with the basic premise - we should
> see inflation increase, but the big question is when. If it does
> not happen soon, you could see gold drop fast. I am waiting to buy
> gold, I am just not sure that $780 is the right price. Too many
> people seem to be waiting to make the GLD play, so that tells me
> that we should see prices in the $600's. Most deflationary scenarios
> take much longer to play out than most people realize, and I think
> the market has underestimated this.
If we are to have an economic recovery, what is there to turn us around? Our economy has become 70% consumer spending. The consumer is tapped out, employers are falling all over themselves to lay workers off. Again, what is there to turn us around? I cannot figure it out. Government spending is a dead end as it is all deficit spending. Maybe we could all work for China?
On Dec 10 10:17 AM User 292053 wrote:
> Conventional thinking in very different times. Deflation will RULE
> as it is the only rationale way forward---houses in the USA were
> simply over-priced/valued due to the moronic interest trate policy
> conducted by the Fed and the idiot Greenspan pressured by even dumber
> politicians. Big Ben has the same disease----he believes he can actually
> change things and get back to the condition Greenspan created. This
> is the last thing we should be looking for. There is a reason banks
> don't lend---the risk profile sucks---and they know it. We need to
> take our medicine and have a big sleep(2 years) and we should be
> well on our way to recovery. Inflate our way out and the USA dollar
> will NOT be the denonminator in the future for commodities and then
> we are really in hot doodoo!
This is what will happen after Obama gets sworn in.
Well the US has been that college kid for the last decade or so. But instead of a healthy, decompression (i.e. sleeping), we have decided to up the stimulus and are now starting to use cocaine. Methamphetamines are next.
Coffee and adderol is one thing. One really good night of sleep and you're good to go. Coke and meth is a whole other level.
So, the answer is actually simple: dramatically smaller government equals more freedom for the people, which leads to more innovation and the self-reliance that *made* this country.
fairtax.org
On Dec 10 10:46 AM sheople wrote:
> User 292053
>
> If we are to have an economic recovery, what is there to turn us
> around? Our economy has become 70% consumer spending. The consumer
> is tapped out, employers are falling all over themselves to lay workers
> off. Again, what is there to turn us around? I cannot figure it
> out. Government spending is a dead end as it is all deficit spending.
> Maybe we could all work for China?
Gold has a 1-2-3-4-5 pattern on the monthly chart from 2002 to 2007. Using Elliott Waves analysis; it only means that a correction has to happen before gold can have the next wave rally on the higher degree level.
With this kind of pattern on the lower degree monthly chart; highest probability will be $430 for gold in 5 to 8 years.
What will cause gold to go down that route?
I dont know.
Just like Dow Jones at 14,000 on July 2007; the projected target was 4,950 in less than 3 years (it actually went higher to 14,200 by Oct 2007 requiring an adjustment to projected target of 4,750 instead of 4,950 with the same time frame).
At that time; nobody knew what will cause Dow Jones to go down the way it did now. Today, we know the multiple reasons or what happened specially in Sept 2008 why Dow Jones went down like crazy on the lower degree monthly chart after making a 1-2-3-4-5 pattern on the higher degree quarterly and yearly charts.
For gold perhaps deflation, perhaps something else that will still have to happen in the future. What is clear from the monthly chart is that it has lost whatever momentum it needs to mount a sustained rally on the current weekly and monthly degree levels.
Oil went thru the same process of losing momentum; the difference between oil and gold was that oil lost momentum drastically while gold grudgingly lose momentum. That is why oil at $40 was not surprising at all with $37 the initial support on the monthly chart that can provide some kind of a bounce.
Once the spectre of deflation becomes clearer or something else happens in the future; downside momentum for gold will accelerate.
We are in deflation.
Wages are not a component of the CPI.
"Quantitative easing aims to flood the financial system with liquidity and absorb excess cash through monetization or purchasing of government securities."
Isn't this backwards? If the Fed is purchasing government securities, dollars go out into the economy. What am I missing here?
The market isn't making you this offer because it is expecting a hyperinflation tomorrow. It expected that as recently as 6 months ago, but everyone betting that way lost everything and is dead broke as a direct result.
You are SOO right!
Monetary policy has been completely ineffective yet no one talks about the only thing that WILL turn this around NOW - a radical reform of fiscal policy via scrapping the current tax code! If you want to see the Dow go up 2,000 points in one day, have Congress make Bush's capital gain and dividend taxes permanent! If you want to see the Dow up 5,000 points in the next six months, read up on the Fair Tax (fairtax.org).
Not only would hundreds of billions of $ held by US corporations in foreign countries come rushing home, but the ability of Congress to screw up our economy and hand out favors via the tax code would be gone forever!
Restore the incentives to take risk and create wealth that has made this country the greatest the world has ever seen.
Deflation in the form of Housing, Stocks, Commodities and unemployment is the Present. How long does it take to get to the bottom? I do not profess to know.
Something scary to think about, Gold futures are trading at or below Spot Gold. IMHO
On Dec 10 08:13 AM JE wrote:
> Real estate is still 3 years away from a bottom. To buy real estate
> is bad advice.
I would vote that we have both Deflation AND inflation spread across different sectors....
As others have pointed out, I think much RE will continue to DEFLATE, as will lots of luxury goods (Coach handbags, private jets, .....)
On the other hand, the essentials of modest everyday living are likely to respond to all this money printing by going up in price ... Why will the middle east want to continue to sell oil @ $45 USD/bbl when there are twice as many USD in the world as there was just a short time ago?
Why won't the price of food head north?
I suspect that many will not have their cake and not eat it either....
On Dec 10 09:32 AM SWRichmond wrote:
> Are you waiting to buy gold, or are you waiting to buy GLD?